Middle East project construction costs on the rise

18 October 2011

The costs for building petrochemicals plants are rising, but project development is continuing to move forward in the Middle East due to favourable government policies

Key fact

The price of steel has risen 12 per cent to pre-economic crisis levels

Source: IHS Cera

When crude prices hit $147 a barrel in July 2008, the Middle East received an influx of petrodollars on a scale never seen before.

The peak in prices was the culmination of four years of huge demand for oil and other commodities, such as petrochemicals and steel, that was being driven by unprecedented economic growth in China.

The Middle East was awash with money and most countries in the region immediately set about spending.

“In 2005-06, it seemed that everyone wanted to build an industrial plant of some sort,” says a petrochemicals industry source based in the Middle East. “The finance was there and back then in Saudi Arabia, the gas was also available.”

By December 2008, crude prices slumped to a low of $32 a barrel as demand dropped and the world entered the worst recession in decades.

Stalled projects

No project in the region sums up that time better than the ill-fated $17bn K-Dow project in Kuwait. The joint venture between the US’ Dow Chemical and the state-owned Kuwait Petroleum Corporation was supposed to be one of the largest chemical plants in the Middle East. In 2009, Kuwait pulled the plug amid rumours of political infighting citing the financial crisis as the reason.

Being so closely linked to oil, petrochemicals prices followed the same downward trajectory as demand for both consumer and industrial plastics and other products collapsed in 2009.

“In 2009, I think most companies that produce commodities had their worst ever year. The chemical industry was no different,” says the petrochemicals source. “But since then you are seeing the region starting to build some impressive facilities.”

In 2005-06, many of Saudi Arabia’s petrochemicals schemes were much smaller in scale than the megaprojects now being built in the kingdom. According to regional projects tracker MEED Projects, construction was completed on 37 petrochemicals plants in the GCC between 2005 and 2008, worth a total of about $11.5bn.

In October 2011, the final investment decision was made by Saudi Aramco and Dow Chemical to build just one petrochemicals complex at Jubail in the Eastern Province at a total investment cost of $20bn.

The reason behind the modest building programme during the boom years was because it is not cost effective to build a world-scale petrochemicals complex when commodity prices are high.

In 2009, spending for oil and gas projects in the Middle East bucked the global trend and actually rose. Contract awards for oil and gas schemes totalled more than $70bn in 2009, compared with just over $30bn in 2008.

While the low oil prices in late 2008 and 2009 were certainly a blow, the GCC’s oil producers still posted huge revenues in the previous years, which meant that the damage was short-term.

Saudi Arabia’s oil income touched $281bn in 2008 before dropping to $157.4bn in 2009 and recovering to $196.2bn in 2010.

This gave GCC oil producers the cash to pursue their long-term aim of adding extra value to huge oil reserves.

Key areas across the whole hydrocarbon sector were identified that would enable the GCC to achieve its aim of becoming a global hub for the chemicals industry and a swathe of multi-billion dollar projects were planned. These included not only downstream petrochemicals projects, but also upstream gas projects that would provide feedstock.

Cost advantages

Several factors helped the UAE and Saudi Arabia, who had the most money to spend. The first and most critical factor was raw materials costs.

In 2007, the price for a tonne of semi-finished steel was more than $1,000, but by July 2009, it had fallen to $382 a tonne. Other material prices also fell in price.

“[The GCC] picked the right time to start building these plants,” says a source from an international contractor based in the Middle East. “The rest of the world was recovering from the [financial] crisis and [countries in the Middle East] were initiating one the biggest downstream capital expenditure programmes ever seen.”

Another factor was the lack of credit available in the global banking system. Projects that were not backed by government-owned companies could not get access to finance during the 18 months after the global economic crisis hit.

Outside the Middle East, the process plant construction market experienced a severe lull in activity in 2009. This played to the region’s advantage by attracting international engineering, procurement and construction (EPC) contractors to the Middle East. With competition came lower prices.

“We decided to focus on the Middle East from 2009 because this was the only place where large contracts were being awarded,” says an executive who works for a South Korean EPC contractor. “But the increased competition meant that we had to become very aggressive with our pricing to ensure we had a chance of winning work.”

The South Korean’s aggressive pricing strategy was a huge success in the petrochemicals sector in the Middle East. The majority of awards over the past three years have been secured by companies including GS Engineering & Construction, Daelim Industrial and Samsung Engineering.

Low bids

“The South Koreans have been pretty much unstoppable and the low prices they have bid now means that many customers for these plants expect low prices now,” says the Middle East-based contractor.

Jump to 2011 and what is the largest petrochemicals project in the region is currently being tendered by its joint venture partners.

The $20bn Sadara Chemical Company complex at Jubail has awarded five contracts. One is the engineering, procurement, construction and management (EPCM) contract for the offsites and utilities, with a bundle of four other packages going to Daelim Industrial.

Sources in the kingdom say the prices being tendered for the work are still aggressive and highly competitive. But other factors such as higher commodity prices has meant procurement and construction costs are rising again.

This means that the region should start to see more priority contracts being tendered on an EPCM cost reimbursable basis. Higher commodities prices usually indicate a shift away from the higher risk on lump-sum turnkey execution strategy.

“The kingdom’s process plant market is one of the most competitive in the world at the moment in regards to the EPC contracts on offer,” says the international contracting source.

“But some of the packages being offered are too risky even for the [South] Koreans.”

In 2011, the price of building a petrochemical plant rebounded to 2008 levels. This has been driven by an increase in steel prices, which have risen by about 12 per cent since 2010.

Between third quarter 2010 and first quarter 2011, the cost of designing and constructing petrochemicals plants witnessed its largest six-month rise since the third quarter of 2008, according to analysts at the US’ advisory IHS Cera.

A report released by the company in June stated that demand has led to increased lead times for products. This has subsequently allowed equipment manufacturers to start passing on to the end user the higher raw materials prices, that they had been absorbing during the quiet period of 2009.

Labour costs have also risen in 2011 as inflation in emerging markets coupled with higher demand for skilled workers has resulted in increased salaries, as well as restored overtime and benefits.

Cost inflation has caused the price tag of the Sadara complex to rise to $20bn from initial estimates of $15-$18bn.

The PetroRabigh phase II project, a joint venture between Aramco and Japan’s Sumitomo Chemical is likely to be delayed by at least six months due to funding issues.

Rising prices

Although the PetroRabigh project is sure to go ahead, the higher costs are starting to have an impact on some of the large process plants planned in Saudi Arabia, especially ones with private or independent ownership.

The $1bn Dammam 7 project planned for Jubail had to double its capacity to ensure that the economies of scale for a large petrochemicals project made it financially viable. Now this project has been postponed due to problems over financing the scheme.

Despite the rising costs, the petrochemicals industry has strong backing from regional governments. Many of the initial start-up costs can be mitigated against the lowest feedstock prices in the world, as well as highly subsidised land and utility bills.

“These plants are being built to be the bedrock of the region’s industrial plans for decades to come,” says the source from the international contractor.

“So while prices may be going up now, it is likely that in the long-term the investment will be highly profitable.”

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